Up in smoke

Foreign investors in India’s coal sector should consider investment treaty protection to mitigate against their investments going up in smoke, say Jonathan Leach and Markus Burgstaller of Hogan Lovells.

On 24 August 2014, the Supreme Court of India ruled that the process for allocating coal block licences in India over the last two decades had been “arbitrary and illegal”. The entire allotment process was described as “fatally flawed” mainly due to a lack of fairness and transparency.

The decision affected the provision of licences to produce coal from designated mining blocks, with coal mining described by the court as an “extremely important element in the industrial life of developing India”.

Following this decision, on 25 September 2014, the same court determined that there could only be one of two possible consequences flowing from its earlier finding: either the cancellation of the allotment of all coal licences made from 1993 to 2010; or alternatively, the cancellation of only those blocks which had not yet begun producing coal (while leaving intact those blocks that were already producing). Unfortunately for domestic and foreign investors, the court decided upon the more radical option: it cancelled all 214 coal licences.

NOT WITHOUT PRECEDENT

In reaching that decision, the court dismissed proposals to judge the allotments on a case-by-case basis. Investors had pleaded for leniency in requesting individual hearings or the appointment of a committee to review the allocation history of each individual mining block rather than cancelling the coal licences in one, all-encompassing ruling. Instead, the court held there was no legal basis to uphold any allotment of the right to mine coal in those blocks while the flawed process was in effect, irrespective of the individual circumstances.

For those 42 blocks that had begun production, the cancellation will not take effect until 1 April 2015. At this time, Coal India, the state-controlled coal mining company, will take over the coal blocks and continue extracting coal from the mines situated in those blocks. In addition to losing their licences, existing operators of the mines will also face a fine, based on the amount of coal they have produced to date. For the remaining non-active blocks, the cancellation order has had an immediate effect.

Although the cancellation of the coal licences may seem heavy-handed, the approach is not new for India. In 2012, the Supreme Court of India delivered a similar judgment that declared the allotment of licences to use the 2G spectrum as “unconstitutional and arbitrary.” As a result of its decision, all 122 2G licences sold in 2008 were cancelled.

An internal audit into the allotment of the spectrum revealed gross inadequacies in how the spectrum was sold to the public – similar to those found by the Supreme Court in the coal allotment process. In the end, several politicians were charged with bribery and corruption, and the report estimated that the 2G scam cost the country nearly USD 22 billion in unrealised profits.

A TOTAL LOSS?

Although a certain amount of risk is involved when investing in developing countries, foreign investors are not without legal recourse when their investments are harmed by government action. Many foreign investors can seek protections under various bilateral and multilateral investment treaties (BITs and MITs respectively), of which there are more than 2,000 currently in force worldwide, and many of which India is a party to.

However, not all foreign investments qualify for protection, and not every government action will breach the standards of protection found in an investment treaty. Typically, to receive the protections of an investment treaty, an investor must establish that an investment has been made.

Investment treaties contain a broad and non-exhaustive definition of the types of investments covered by them. Some examples of transactions and ventures that typically constitute investments are: construction projects; infrastructure projects; property rights; intellectual property rights; loans; promissory notes; sovereign debt securities; and various investment contracts. Protection in any particular case will depend on the terms of the specific investment treaty.

If the investor and investment qualify for protection, investment treaties can be a powerful legal tool. Otherwise, an investor may be left with what remedies a particular legal system provides. Indeed, several foreign investors lodged investment treaty disputes with the Indian government following the cancellation of the 2G licences.

In September 2013, Mauritian entity Khaitan Holdings lodged a USD 1.4 billion claim against India under the India-Mauritius BIT. At least two other companies also submitted notices of dispute against India over the cancellation of their 2G spectrum licences: Russian telecoms group Sistema and Norway’s Telenor. However, both of these companies later decided not to pursue arbitration, after they participated in fresh auctions for Indian spectrum networks.

INVESTMENT TREATY PROTECTION

Although the standards of protection vary between investment treaties, treaties typically guarantee that a state cannot expropriate an investment without prompt, adequate and effective compensation. Under most treaties, the taking can be direct, such as seizing assets or property comparable to what India has done with the coal licences and 2G licences, or indirect, such as depriving an investor of the value of its investment through regulatory action or other government measures.

Investment treaty protections also protect against a number of other government activities including unfair, discriminatory or arbitrary treatment of foreign investments. Most treaties also provide a standard of protection that allows for the physical protection of the investor and investment. This standard of protection may be infringed following an attack by the government, or a public riot that has caused harm to an investor’s property, where the government has failed to exercise due diligence to prevent that harm.

The protection standard most frequently invoked in cases brought under investment treaties is the fair and equitable treatment standard. It is also the standard of highest practical relevance: the majority of successful claims are based on a violation of this standard. Some examples of governmental conduct which would violate this standard include: a failure to protect an investor’s legitimate expectations; lack of good faith; lack of procedural fairness, due process or transparency; lack of a stable and predictable framework for investments; and discriminatory or arbitrary conduct.

Perhaps most significantly, investment treaties typically provide a forum for foreign investors to bring such claims before a neutral, international arbitral tribunal rather than before the local courts. This is crucial as many investors do not wish to settle disputes before a host state’s domestic courts because of fear of corruption or bias or because they are simply unfamiliar with the domestic legal system.

Most modern investment treaties provide a mechanism for investor-state arbitration – whereby a host state consents to arbitrate claims by a foreign investor before an international arbitral tribunal, without the need for further consent on the part of the host state. This is a powerful tool for investors whose investments have been harmed by the conduct of a state.

The most common remedy in investment treaty arbitration is monetary compensation, which is frequently honoured without the need for enforcement. However, if a state fails to honour an award, investors may take various measures to ensure it is enforced, such as applying to a domestic court to attach assets of the respondent state.

It remains to be seen whether those investors affected by these recent decisions will make use of the protections afforded by applicable investment treaties.

Jonathan Leach is a partner based in Singapore and co-heads Hogan Lovells’ South East Asia international arbitration practice. He is a member of CDR’s Editorial Board. Markus Burgstaller is a partner in Hogan Lovells’ international arbitration practice based in London.

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